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Is Solar Power Still a viable investment?

July 1, 2013

The extraordinary rally of solar panels manufacturers’ stocks including SunPower(NASDAQ:SPWR) and First Solar (NASDAQ:FSLR) have raised this industry’s profile in recent months. Will the staggering rise in shares of solar companies persist? Is it still a good idea to purchase these stocks?

During 2013 (year to date) shares of solar panels manufacturers spiked: SunPower’s stock sharply increased by more than 272%; First Solar’s shares, by 47%. One contributing factor for these companies’ sharp rise in the stock market is their spike in revenues in the first quarter of 2013: Revenues of First Solar jumped by nearly 52% (year-over-year); net sales of SunPower sharply rose by more than 28.6%. On the other hand, not all solar manufacturers have done well in the recent quarter: revenues of Sunedison (NYSE:SUNE) fell by 14.6% in the first quarter of 2013 (year-over-year). The company is still losing money. This didn’t stop the company’s stock to spike by more than 154% during 2013.

Looking forward, will these companies continue to show a sharp rise in revenues? Will these companies current valuation is justified?

Is solar power a growing market?

Based on the above-mentioned companies’ recent growth in revenues, this industry is growing fast. The current expectations are that solar usage will sharply rise in the coming years: The Energy Information Administration predicts that U.S consumption of solar power will rise by 30% to reach 0.306 quadrillion Btu. In comparison, the total renewable consumption in the U.S is expected to rise by only 3% in 2013 (year-over-year). Moreover, the solar energy consumption will rise the highest among all other renewable energy alternatives. The Solar Energy Industries Association also showed a 33% growth in installation of photovoltaic (PV) capacity in the U.S during the first quarter of 2013. This sharp rise in projected to persist.

Furthermore, the decision of U.S policymakers to cut down CO2 emissions by reducing the consumption of coal for solar is likely to keep the high growth rate of this industry in the coming years.

Thus, the industry is expected to sharply rise in 2013, which will reflect in growth in revenues of leading solar panels manufacturers’ revenues. Will this translate to higher profits?

Panel price

Despite the high growth in revenues, the price of panel continues to dwindle. According to the Solar Energy Industries Association the price of PV system price dropped by 24% in the first quarter of 2013 to $3.37/w (year over year). This fall in prices reflects in the very low profit margins of the above-mentioned companies.

SunPower and Sunedison continue to present operating losses; First Solar, however, turned a profit in the first quarter of 2013. But the company’s current operating profit margin is only 7.8%.

In case you may think that the low P/E of companies such as First Solar, which currently stands at 9.5 might make this company attractive. You may consider a different calculation using First Solar’s enterprise valuation to determine its attractiveness as an investment.

The table below shows the valuation of First Solar and its EV to EBIT ratio and the ratio of Environmental and Electrical Equipment markets – two markets that First Solar is related. Even though First Solar’s P/E is low compared to the Environmental and Electrical Equipment markets averages, the company’s EV to EBIT ratio is 9.36, which is higher than the market averages. This means, the company’s current value is more expensive than the market averages.

Funding growth

The biggest problem with high investment costs and little to no profits is finding ways to maintain this growth with funding. For now, it seems that many investors and bankers still believe in the solar industry. This could explain how Sunedison has recently received $100 million in loan from Wells Fargo to finance a 2.7 gig watts of projects Sunedison is developing. Nonetheless, the company’s very high debt-to-equity ratio of 5.31 could eventually hold back the company and it will have to raise its equity in order to keep banks funding its projects. The situation for SunPower and First Solar is much better as their debt-to-equity ratio is much lower at 0.8 and 0.15, respectively.

The bottom line

Even thought the consumption of solar energy is likely to further rise precipitately in the coming months, this industry is still very competitive, which means the profit margins are likely to remain very low. Therefore, I suspect companies that work in this industry won’t be able to turn revenues into high profits that will benefit investors over time.

Disclaimer:The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.